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Avoid haphazard decisions while selling

| 4/11/2011 3:19 PM Monday

Many of us, who exercise so much care while investing, often tend to act in a haphazard manner when it comes to making a decision to sell. While equities are essentially a long-term investment proposition, different investors may have different reasons to cut short their holding period. Whatever the reason, it is important to have a proper strategy to avoid making decisions that are dictated by emotions rather than by logic. Let us analyse a few situations that may require an investor to sell and also discuss the right strategy to make the right selling decisions.

The initial dilemma for many investors is what to look for in a fund at the time of making an investment. As a result, they end up investing in every fund that comes their way. The result is a portfolio that consists of funds that neither match their investment objectives nor their risk profile. It is a well established fact that one must follow certain basic principles for investing in mutual funds. For example, while selecting equity funds, it is vital to consider factors such as exposure to various segments of the market, investment strategy, past performance and portfolio turnover.

Similarly, for debt funds, it could be the load structure, annual expenses and the maturity duration of the portfolio. It is also important to know what to expect in terms of returns and how to measure the performance. Needless to say, a hodgepodge portfolio requires some amount of pruning. So, what should an investor do in such a situation? Generally, one can begin by selling funds that have lagged behind other funds in the same category.

Remember, the performance of a scheme is best measured in terms of total returns. Total return is the percentage of change in the net asset value (NAV), with the ending NAV being adjusted to take into account the dividend distributions made by the fund. Even after identifying the non-performing funds, one must not be in a hurry to exit. It pays to consider factors such as exit loads (if any) and tax implications on account of a selling decision.

Furthermore, one must hold a fund long enough to evaluate its performance. Many of us make the mistake of either holding on for too long or exiting in a hurry. One needs to do a thorough analysis before making a decision to sell. It is quite common to see many investors err on the side of selling funds without giving them time to show what they can do. That is why the track record of the funds in the portfolio has to be evaluated carefully.

To do that, the focus should be on the long-term track record of a particular fund rather than its short-term performance. A long-term track record moderates the effects that unusually good or bad short-term performance can have on a fund. Besides, a longer term track record compensates for the effects of a fund manager’s particular investment style. Discipline in the fund manager’s investment approach is another important factor that needs to be monitored. The pressure to perform can make a fund manager susceptible to an urge to change tracks in terms of stock selection as well as investment strategy.

In other words, while analysing the performance, the objective should be to differentiate investment skills of the fund manager from luck and to identify those funds with the greatest likelihood of future success.

Another reason that might prompt investors to sell in a hurry is volatility in the market. Needless to add, they pay a price in the long run for such a haphazard approach. The key is to recognise that volatility exists in the marketplace and will continue to exist. The investors need to find ways to deal with it. One such strategy is to rebalance the portfolio periodically. Rebalancing is a method by which the allocations to debt and equity are brought back to the original level. This is necessary as one asset class grows faster than another. Rebalancing becomes necessary because we make investments to achieve the best results at an acceptable level of risk. By doing nothing, we violate this premise and get exposed to an unacceptable level of risk.

Another reason to sell can be when a fund outlives its utility to an investor. It could be because of change in his needs, risk profile and time horizon. A situation like this would require a careful examination of the changed circumstances to realign the portfolio.

 

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